Oil's benchmark contract ends at a 14-month low

Prices drop 4%, close under $59 on supply glut, lack of output risks

SAN FRANCISCO (MarketWatch) -- Crude-oil futures fell almost 4% Tuesday to close under $59 a barrel Tuesday, pulling the benchmark contract to its lowest level in more than a year, with pressure coming from swelling U.S. inventories, a lack of risks to output and doubts that key oil producers will take formal action to reduce supplies and stem the drop in prices.

The market has "high inventories, high levels of exploration activity, no supply shortage, low consumption at this time of the year and no Gulf [of Mexico] hurricanes -- with lower chances of having one," said James Williams, an economist at WTRG Economics.

"The combination of these factors is consistent with prices below $50 per barrel."

The combination of high inventories, high levels of exploration activity, no supply shortage, low consumption at this time of the year and no Gulf hurricanes are 'consistent with prices below $50 per barrel.'
James Williams WTRG Economics

Crude for November delivery closed down $2.35 at $58.68 a barrel on the New York Mercantile Exchange, after reaching a low of $58.60. These are levels the contract hasn't seen since late July 2005.

The contract fell 3% Monday amid speculation that even if Venezuela and Nigeria cut production as they have said they will, it would do little to dent hefty supplies of crude and its products.

On Tuesday, traders questioned whether leading oil producers, notably Saudi Arabia, would lower production to stop the decline in prices.

Front-month prices have lost more than 20% in the past two months.

Among the oil products, November unleaded gasoline futures fell 5.2 cents to close at $1.4567 a gallon and November heating oil lost 4.79 cents to end at $1.6539 a gallon.

Venezuela and Nigeria said last week that they would cut production by a total of 170,000 barrels per day as of Oct. 1, but the Organization of the Petroleum Exporting Countries has denied that there was any coordinated plan for its members to cut output, according to Dow Jones Newswires reports.

"Both of these cuts are symbolic only, and will hurt those two producing countries far worse than it will impact the crude-oil market," said Charles Perry, chairman of energy-consulting firm Perry Management.

At the same time, North Korea has returned to the news on Tuesday, announcing plans to carry out a nuclear test "in the future." The foreign ministry said in a statement that the test is aimed at bolstering the country's defense in the face of U.S. hostility, the BBC reported.

The United Nations imposed sanctions on North Korea in July after it test-fired a number of long-range missiles. Six-nation talks on North Korea's nuclear program have been stalled for more than a year.

But "threats from North Korea, or even Iran, must turn to actual action before the oil markets will perk up," said Kevin Kerr, editor of Global Resources Trader, a newsletter of MarketWatch, the publisher of this report. "The market is tired of veiled threats."

"In addition, the next few days of mild temps in the Northeast may also calm nerves about the coming winter and put slightly more pressure on oil prices," he said.

Even so, "as cold weather settles in by the end of the week, that may all change next week," he warned.

Price views

All told, conflicting news about demand and supply has "led to a very confused market," said Rakesh Shankar, an economist at Moody's Economy.com.

"This is a sentiment driven market, and if the bears win the day, then prices could fall as low as $55 by year end," he said.

Perry said prices haven't bottomed just yet. "We still think that we will see a bottom in the high $50s (above $55) in the next month, plus or minus," he said.

This is the time of year the market sees demand for products decline, and inventories rise, he said. And "Iranian President [Mahmoud] Amadinejad has been amazingly quiet since he visited the U.N. and the United States -- no threatening speeches," he said.

Hurricane threats fade

Contributing to the likelihood of lower energy prices, forecasters at Colorado State University reiterated their call for below-normal storm activity during the rest of the Atlantic hurricane season, blaming faster-than-expected El Nino weather conditions in the Pacific Ocean, Dow Jones reported Tuesday.

The El Nino conditions put an early end to hurricane formation in the Atlantic basin, said hurricane forecaster William Gray, according to the report. The forecasters expect two more named storms, one more hurricane and no more major hurricanes for the rest of the season.

Forecasts earlier this year for an unusually active hurricane season had prompted concerns over damage to energy assets in the Gulf of Mexico.

Meanwhile, analysts at Societe Generale, who downgraded a number of European oil producers on Tuesday, said there's more price weakness to come.

"With (Brent) crude oil now at $60 a barrel, we think the markets will next want to test OPEC's willingness, and in particular Saudi Arabia's, to defend a certain price, in the region of $50/barrel," the broker said.

"The markets believe that, in the end, there isn't as much pressure on fundamentals as was thought two or three months ago, and this should lead to a steady decline in the price of crude."

The bank lowered its 2006 Brent price to $66.10 from $68.80, the first time in more than two years it has cut its oil-price forecast.

Supply data watch

Hefty U.S. supplies of crude and its products have been the key driver for oil's decline over the past several weeks.

Last week, the Energy Department reported a sixth-weekly decline in motor gasoline stocks, and showed that distillate inventories rose for seven weeks straight. See full story.

Analysts at Wachovia Corp. and Fimat USA both predict that crude supplies fell 1.1 million barrels in the latest week. A survey of analysts conducted by Platts shows that the market, on average, is looking for a fall of 700,000 barrels.

Distillates likely rose by 1 million barrels, Wachovia said, or by 2.3 million, according to Fimat's estimate. Platts' survey puts the forecast at an increase of 1.3 million.

Potential supports

High levels of petroleum supplies and expectations for more distillate and gasoline inventories offset concerns about renewed violence in Nigeria, the world's sixth-largest oil producer.

Militants kidnapped 25 Nigerian oil workers in the southern delta region, Royal Dutch Shell
RDS.A, +0.09%
said Tuesday, according to an Associated Press report. An army spokesman said earlier that at least five people died and nine were missing after about 70 militants sank two military patrol boats escorting the oil workers in the delta Monday, the report said.

Right now, the "only support comes from a supply-risk premium" in crude's price, said WTRG's Williams.

"With only about 1.5 million barrels of spare oil production capacity the market could not weather a complete interruption from Iran, Nigeria or Venezuela," he said. And "all of the price above $45-$50 is determined by the markets perception of the chance of a supply interruption."

So far, the market's perception of lower "geopolitical risk" has helped lower oil prices, but "in that geopolitical risk is the potential for an OPEC production cutback, which can support price," he said.

It's also important to note that since 1974, prices for a typical barrel of crude oil has averaged a little under $34 per barrel in today's dollars -- and averaged below $30 for half of those years, he said.

Elsewhere in energy trading, natural gas saw its November contract close higher, up 11.6 cents at $5.759 per million British thermal units after an earlier decline to $5.46.

The Energy Department will provide its weekly update on natural-gas supplies in storage on Thursday. Market estimates call for an increase of 70 billion to 90 billion cubic feet in supplies for last week, Fimat said, pegging its own estimate at a rise of 81 billion.

Analysts at Strategic Energy & Economic Research predict a climb of 77 billion noting that a year ago, supplies rose 45 billion. The five-year average climb is 66 billion, it said.

In equities, benchmarks tracking stocks in the oil and gas sectors fell, with the Philadelphia Oil Service Index
OSX, +0.91%
suffering the biggest decline. See Energy Stocks.

And in Monday's metals trading, gold futures tallied a drop of over $29 an ounce in three losing sessions. See Metals Stocks.

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